Should You Incorporate Your Business

A corporation is a separate legal entity, which is formed by application to either the federal government, or one of the provincial/territorial governments. The corporation issues shares to the owners, or shareholders. The funding of the corporation can be done through the issue of shares, or by borrowing. Instead of investing a large amount in shares, shareholders can lend money to the corporation, and invest only a minimal amount in the shares. This way, when the corporation becomes profitable, the shareholder loans can be repaid without attracting income tax.
Being a separate legal entity, a corporation pays corporate income tax, which is calculated completely separately from the owners' personal income tax. Advantages of incorporation: - One of the biggest advantages of incorporating a business is limited liability. This means that the liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation. However, many incorporated small businesses are not able to get bank loans without the personal guarantee of the shareholders, so this eliminates part of the advantage of limited liability. The personal assets of the shareholders are protected from lawsuits against the corporation. However, shareholders who are directors of the corporation can be held legally liable for some debts of the corporation (such as GST and payroll taxes) in certain circumstances. - Another major advantage for a profitable small business is the income tax advantage.
A Canadian controlled private corporation, or CCPC, pays a much lower rate of tax on the first $250,000 of active business income than would be paid by an unincorporated business. Active business income generally does not include investment income or rental income. The combined federal + provincial tax rate on the first $250,000 of active business taxable income for a CCPC varies from approximately 16% to 22%, depending on the province. Keep in mind that this tax advantage is mainly a deferral of taxes until the profits are paid out to the shareholder. If all the profits are paid out to the shareholder as they are earned, leaving the corporation with little or no taxable income, then they will be taxed entirely as income of the shareholder, at personal income tax rates. - Another tax advantage of incorporation is the $500,000 capital gains deduction on the sale of shares of a qualifying small business corporation.
One of the qualifications is that the corporation must be a CCPC with active business income. Disadvantages of incorporation: - Incorporation is the business structure with the highest setup and administrative costs. - Incorporation is the most complicated business structure. It is very important to take extreme care in setting up classes of shares, deciding who will be shareholders (spouses, children) and how much control they will have (control is determined by % of voting shares owned). Professional advice can avoid serious problems. - Business losses cannot be written off against other income of the owners (shareholders). - More administrative work is required for a corporation. This includes annual reports filed with the corporate registry, and corporate tax returns which are filed separately from the owners' personal tax returns. Generally, the higher the net income of your small business, the more advantageous it is to incorporate instead of remaining as a proprietorship.
No matter what the type of business structure, spouses and children can be employed by the business, thus effectively splitting income. However, amounts expensed must be reasonable amounts based on services provided, and must actually be paid to the spouse and/or children.